The Mercatusstudies that Tyler wrote about this morning have received quite a bit of harsh criticism, especially from the left, including this Jonathan Chait piece at TNR. Chait argues that the study misses the point that "labor is fungible." The Garret Jones & Dan Rothschild study shows that 58% of workers hired by the stimulus spending were already employed elsewhere, suggesting that "job creation" is not a good proxy for "increase in net employment." Chait's response can be summarized as "well if those 58% of workers left other jobs to take stimulus-funded ones, surely their previous employers would now be able to hire a worker to fill their spot, thus there is a big increase in net employment even if the stimulus-funded jobs go to the already-employed."

Chait's assumption of the fungibility of labor is the key. His argument presumes that labor can easily be substituted in this way and that the human capital of those workers hired for stimulus-funded projects is the same as those in the unemployment lines. That's the only way that the unemployed person could be swapped in when the stimulus-funded worker is bid away. From an Austrian perspective, human capital, like physical capital, is most emphatically not fungible and is heterogeneous in use. Thus there's no reason to believe that the unemployed workers would be a substitute for the bid-away worker. Workers, like physical capital, have to fit into the jigsaw puzzle. Their human capital must be complementary to the human and physical capital in the firms where the labor has left.

This is particularly true when we recognize the way in which the boom of the 2000s also distorted the structure of human capital across the economy. It may well be that the currently unemployed are examples of human capital malinvestment and that they will have to "refit" themselves in order to find work in the post-recession economy.

If you don't believe me, check out this comment at Marginal Revolution from someone in the middle of all of this who makes this argument with real-world experience I cannot match (my emphasis):

Dhanson August 31, 2011 at 4:17 pm

Those of us who actually work in industry and are involved in large engineering projects of the type the stimulus was designed to ‘stimulate’ could have told you this without waiting for a study. We tried to. No one was listening.

It is maddening to hear ‘workers’ talked about as if they are interchangeable – Oh, a whole bunch of home construction workers have been layed off? Don’t worry, we’ll build a road or a bridge and employ them!” The only problem being that the type of construction home builders are trained for has nothing to do with bridges. Perhaps people like those in the Obama administration lack the appreciation for the real complexity of these jobs and assume that any blue collar work is trivial and interchangeable with a little retraining, but it’s not the case.

Not only that, but the people who can *start a project are very different than the people needed to bring it to completion, and in general the people needed at the beginning of a project are the least likely to be unemployed. In fact, even in a recession there is a shortage of such people. So it was predictable as rain that new stimulus projects would have to scavenge project leaders, architects, managers, and senior engineers from other existing projects that may have more value. It was absolutely, 100% unavoidable.

Not only that, but it is incredibly destructive: Pulling a manager from an existing project can cause damages far exceeding the salary of that person. If a project manager or architect is enticed away from a project that has a $100,000 per day development cost, and his leaving causes a month of delays while a new manager is found and brought up to speed, that’s a cost that will never show up in the stimulus accounting – but his $150,000 job will be counted as a ‘job created’. No one will know that in addition to the stimulus money used to hire him, the real cost of that job was an additional $3 million dollars. I’ve never seen a single Keynesian model take that kind of destruction of existing projects into account or try to quantify the effect. You’d think this might be important to consider – especially in an era where specialization is so important, where even low-level positions require specialized training.

It was also inevitable that some of the people hired would be pulled out of retirement – when you need top guys, you’re not going to find them in the unemployment line. You’ll find them sitting on their sailboats in the Carribbean.

No one but the Austrians seems to care about the actual fine structure of the economy, and the effect a barrage of government money might have on it. None of the people driving policy seem to have an understanding of just how long and complex supply chains are, how fragile they can be, and what it does to a company to pull key people out of existing projects because they were enticed away by stimulus programs.

My company has hundreds of job openings. OUr inability to fill them has nothing to do with aggregate demand – we simply can’t find the kinds of people we need. The bad incentives baked into this economy for the past two decades have diverted the workforce into non-productive areas. It’s pushed people out of science and engineering and into finance and law. The bloated housing sector attracted people away from computers and electronics into carpentry and plumbing. We’ve distorted our labor pool, over-built in numerous industries while leaving chronic shortages in others. Easy access to student loans and easy, long-term repayment has disconnected the choices of students for school and faculty from the economic needs of the country. All of these problems are completely masked by focusing on aggregates.

Let me ask a simple question: If your productive capacity is totally focused on making tables, but your population has plenty of tables but has a real shortage of chairs, and no one is trained to make chairs, how much fiscal stimulus would you need to pick up aggregate demand? Answer: Infinite. People don’t want more tables at any price. As long as that’s all you’re offering, aggregate demand will remain low, and all your table makers will remain unemployed. In fact, the stimulus is just masking the problem and delaying the necessary adjustment to a ‘chair economy’.

Aggregate demand may be way down, but Apple has no problem selling every iPad it makes.

I guess maybe in the past, in a simpler time with simpler labor requirements, you could get away with assuming that the law of large numbers would apply and labor could be treated the same. Who says that’s still the case?

As Garett Jones said of that comment: +1. I might go +100. And this is why capital theory is what ultimately distinguishes the Austrian understanding of market economies and boom and bust from all of the alternatives.

"Although human spiritual and material achievements have been rooted for time immemorial in human freedom, the current, traditional approach to economic development has tended to pay only lip service to the fundamental role of freedom in development. More often than not, orthodox development strategies resulted -- intentionally or not -- in self-defeating policies that had the effect of hampering people in exercising their free will to own, work, save, invest, trade, innovate, create, and so on. As New York University economic professor William Easterly (2001, p. xii) put it, while busy promoting new remedies (from foreign aid to investment in education and machines) and engineering new schemes (from giving loans conditional on reform to debt relief), the development community has too often 'peddled formulas that violated the basic principles of economics in practical policy work.' The problem was not the failure of economics, but the failure to apply the basic principles of economics in a consistent manner, starting with the key role of freedom as the ultimate incentive for people to lead lives that they value."

I am always struck by how by simply getting policies that would align with basic principles of economics, the lives of billions would be improved, and yet it seems so difficult to eliminate those policies in operation which violate the basic principles and have so obviously failed.

Besides Chauffour's book, the monograph by Richard Epstein,Free Markets Under Seige lays out the case for "picking the low hanging fruit" in public policy brilliantly. But somehow our arms are too short to even grab those fruits within our current political climate. We teachers of economics need to do a better job of communicating to not only our scientific peers and students in our classes, but to public policy decision-makers, and the general public.

This piece has been getting a lot of play today in which Michael Lind accuses both Mises and Hayek of being friends of autocracy and fascism (you can guess why - the Liberalism quote ripped out of context and the supposed Hayek-Pinochet connection). He also misunderstands the libertarian critique of democracy. Others have responded nicely to the fascism stuff, including Jeff Tucker and Jason Kuznicki.

I, however, want to raise a different objection. Lind writes:

For that matter, where was the libertarian right during the great struggles for individual liberty in America in the last half-century? The libertarian movement has been conspicuously absent from the campaigns for civil rights for nonwhites, women, gays and lesbians.

Aside from the fact that there wasn't much of a libertarian movement in the 1960s, which might explain the small number of libertarians on the civil rights for nonwhites issues, I would ask Lind which US political party was the first one to have a gay rights plank in its platform? It wasn't the Democrats Michael, it was the Libertarian Party, back in 1980.

Sexual orientation, preference, gender, or gender identity should have no impact on the government's treatment of individuals, such as in current marriage, child custody, adoption, immigration or military service laws. Government does not have the authority to define, license or restrict personal relationships. Consenting adults should be free to choose their own sexual practices and personal relationships.

So really Michael, where were liberals when it came to gay and lesbian rights issues? Behind those fascist libertarians, it would appear.

Smear jobs like this are a sign of progress because they come from a place of fear. You don't have to smear folks you think are irrelevant. It's when ideas matter that they meet the bar of warranting a smear. Thanks for the compliment Michael.

My colleague Petrik Runst and I had a lovely chat this afternoon at a local bistro to discuss a paper project that we're working on. Over the course of that conversation, I articulated a point that neither one of us had thought about quite so clearly before and I want to take it for a test drive here.

Part of the argument of this paper is noting the evolution of socialist thinking, specifically from the emphasis of the early Marxists on exploitation and alienation to the Frankfurt School's more singular fixation on alienation. One reason we put forward for this change is that it became harder and harder to argue that really-existing capitalism had somehow materially impoverished workers in the way Marx argued it would. With rising living standards, the socialist critique shifted away from economic exploitation to a more narrow focus on alienation, often with a psychological twist (thanks to Freud I think) that Marx would have rejected given that he saw alienation as totally the result of the anarchy of commodity production under capitalism.

In the course of our conversation, I raised a point that Don Lavoie used to make all the time: much of Marx's critique of capitalism is like a photographic negative of what he imagines the socialist world will look like. In other words, the reason that exploitation and alienation are problems of capitalism is that Marx can envision a world in which neither one exists. Specifically, if the participatory but still unified planning of all economic activity (and the elimination of exchange/markets/prices/commodity production) is possible, we will eliminate alienation and exploitation. The particulars of the argument aren't that relevant here, but this is, in my view, a plausible reading of Marx.

For years I have been trying to teach students -- from Econ 101 to PhD students -- that there is a simple linear relationship in the real world of political economy that goes:

Bad Ideas ---> Bad Policies ---> Bad Outcomes

Political economy ain't rocket science. But it is a discipline that forces one to focus on ideas and the implementation of those ideas in public policies. Ideas -- some deeply rooted in philosophy, others focused on more technical propositions about the way the world works -- are weaved together to form more or less coherent frameworks. Those frameworks then suggest solutions to pressing problems (perceived or real) in the economy that in the vast majority of intellectual frameworks guides government action. Bad root ideas become coherent but incorrect frameworks, and the solutions offered therefore are the wrong ones for the problems identified.

Given this argument, the challenge I have is to explain the persistence of bad ideas in the realm of competitive politics. The bad outcomes means that there are proverbial $20 bills lying all over the sidewalks of the political economy space. Why aren't they being picked up?

One of the great strengths of the market economy is the feedback provided by the buying, and abstaining from buying, behavior of the customer. If the Ford Edsel is introduced and the consumer does not buy, then Ford shuts down production and reallocates resources to the production and distribution of a car that better satisfies the demands of the consumer. But the feedback mechanism in the supply and demand of public policies is not as forceful as in the market. Both the demand side and the supply side of politics has distortions that prevent the easy elimination of the $20 bills.

But the "Bad Outcomes" are not trivial when it comes to policy errors. In the 20th century, policy errors led to not only undue suffering by citizens, but in the most extreme forces of policy error the death of millions. In the 21st century, policy errors have threatened security and the very financial stability of the global economy. Why such persistence?

In part, I want to contend, because the debates over policies are confused. In the narrative I would tell for post-1980 economics and economic policy, I'd stress the decline of Keynesian ideas within the economics profession, but the persistence of Keynesian ideas, frameworks and policies (and the institutions that Keynesian economics ushered in during the post-WWII period) in public policy.

Yes, the post-1980 world was one of the ascendency of "relatively" free markets combined with some deregulation, privatization, and open trade. But these policies were always chosen within a broader framework of Keynesian political economy and instituted by Keynesian policy institutions. What we experienced in the UK and the US in the post-1980 world was one of "conservative" Keynesianism, rather than "liberal" Keynesianism, but what we didn't experience was free market economics. In addition, the collapse of communism and the opening of the economies of India, China, and Latin America (and lesser extent Africa) to global trade also reinforced the marginal shift toward "relatively" freer markets and thus the improvements in human well-being.

In short, I am suggesting that there has been a disjoint between the rhetoric and reality of post-1980 political economy. And, I believe this disjoint continues to plague our current policy discourse post-2008. Consider carefully these two recent commentaries by two very significant economic thinkers: Joe Stiglitz and Ken Rogoff.

Stiglitz's article is entitled "A Contagion of Bad Ideas" and the narrative he tells about how in response to the failure of free market policies we needed to respond with a Keynesian stimulus, but that the Keynesian stimulus ballooned budgets, which have now resulted in massive spending cuts. In Stiglitz's analysis will result in wasted resources and undue suffering that will persist for years to come. Again, his framework is coherent, but is it the right framework? It is internally consistent, but is it consistent with the reality it purports to address?

Rogoff's article is entitled "The Second Great Contraction", and it continues the theme from his book with Carmen Reinhart, This Time is Different. The bottom line, the post-2008 situation is not defined by a recession in need of a correction, but instead by a global financial system that is so far over-leveraged that drastic steps at de-leveraging will be required for many years -- default and inflation being among the primary tools. I think Ken Rogoff is a brilliant man, but I honestly cannot buy the cavalier way he talks about 4-6% inflation for several years to set the situation right. The costs of inflation, I believe, are being way underestimated by him and others when they make such suggestions. Again, Rogoff's framework is coherent, but is it the right framework? It is internally consistent, but is it consistent with the reality it purports to address?

Could either Stiglitz or Rogoff make their respective arguments if they saw money as non-neutral, if they saw the capital structure in the economy as consisting of heterogeneous good with multi-specific uses, if they saw the market as a process of ongoing entrepreneurial discovery, learning and adjustment guided by signals and incentives? I often ask my students to think of the capital structure as made up of lego pieces rather than play-doh, and to think about the costliness of mistakes in the construction. Errors with lego constructions require pulling apart piece by piece, carefully setting aside to not lose a piece, and rebuilding piece by piece; errors with play-doh require smashing and remolding with your hands in one-step. One is very costly, the other minimally so. But my lego versus play-doh is just an analogy, not analysis.

At the risk of de-legitimation, I think a major problem with the conventionalist methodology of model and measure in economics is that it blurred some of the major lessons from logic and critical reasoning. Formal modeling was supposed to eliminate confusion in though by making assumptions explicit, and thus eliminating the confusion that results in literary exercises when the same words are used to mean different things, or different words are used to mean the same thing. But as formal tractability became a criteria in theory choice, models became mere instruments. We built toy economies, populated by robot agents. Realism of assumptions was jettisoned. We built coherent frameworks, but sacrificed correspondence to the world we originally wanted to study. Rather than worry about the distinction between validity and soundness, and between good and bad arguments, as matters of critical reasoning; the procedure of testing models against the data would eliminate weak reasoning. It wasn't a matter of philosophic argument, it was a matter of scientific testing.

The post-2008 debates highlight how little we have progressed since 1930 as a discipline. There are $20 bills lying all over the sidewalks. And if we despair over the hopelessness of politics, we must remember Frank Knight's words: "To say a situation is hopeless is to say it is ideal." Obviously, our situation is not ideal, so that must mean it isn't hopeless. Right ideas forged into the right framework can, and will, produce the right public policies that can scoop up those $20 bills and improve the lives of billions of people. But I don't think we get there again until we eschew our preoccupation with toy economies populated by robot actors, and instead work on developing an economics based on the realism of assumptions, populated by capable but fallible human actors, who interact within specified institutional environments that structure incentives, produce a flow of information, and provide disciplinary feedback.

We need ideas, frameworks and policies, but lets make sure they are:

Good ideas --> Good Policies --> Good Outcomes

Political economy ain't rocket science, but it matters a heck of lot more whether we get it right or wrong. As Ludwig von Mises put it:

The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.

What do you think of that list? And, what do you think it says about Mises's stature as an economic thinker if even Samuelson signaled that he would have been honored with the Nobel Prize for his contributions to economic science?

One of my favorite political economists, Chris Blattman (who I’ll have the great pleasure of meeting next month when he comes to speak in Pete Boettke's PPE workshop), discusses a paper of mine published some years ago in the Journal of Comparative Economics entitled, “Better off Stateless: Somalia Before and After Government Collapse.” [Ungated, but incomplete, version here (see comments below)].

Chris buys my paper's basic point: some governments are so bad that they’re worse than no government at all. But he wonders whether this applies to Somalia, which my paper uses to illustrate its idea.

Chris requested me to respond to his post. Given my admiration for him and his work, I thought I should oblige.

1. Chris questions the quality of the data (drawn from the UN, World Bank, and WHO) relating to Somali development.

I agree. The best feature of these data is that they are (or at least at the time of my research on this topic, they were) the best data that are available. Of course, that doesn’t mean they’re “good.”

There are two ways one can proceed in light of this:

[A] Don’t use these data, which in the Somali case would mean refraining from making any empirical investigations or observations about development at all.

[B] Use them with the caveat that they’re merely the best available data.

I went with option [B].

2. Chris wonders if I’m too focused on the short run. Although a constrained Somali state may not be feasible at the moment, with some growing pains, it may be feasible in the future.

I again agree. As I often point out when people ask me to comment on this topic, the critically important thing for thinking about anarchy and development in Somalia (or anywhere else for that matter) is to compare development under Somali anarchy to potential development under Somalia’s relevant institutional alternatives. That means systems of government that are actually in Somalia’s “institutional opportunity set.”

This set is considerably smaller than the institutional alternatives that occupy an unconstrained set. The unconstrained set includes “first-best governments,” such as those we observe in North America and western Europe.

My beef has long been with persons who argue that Somali statelessness is “bad” by (often implicitly) comparing it to governments that are the exception (such as the United States’ government) instead of the rule—let alone the rule in sub-Saharan Africa. It seems to me that the knee-jerk reaction when looking at Somalia's problems is to respond with a boisterous “They need government!”, ignoring the rather important detail of what kind of government Somalia would be likely to get if it were to get one. (For more on this, check out Chris Coyne's paper on Somalia and the nirvana fallacy).

If Somalia had a random pull on the global distribution of governments, I think an argument could be made that it may still be better off stateless. (For those who haven't already, as a fun exercise, take a gander at Foreign Policy’s “Weak and Failed States Index” and see what most governments in the world actually look like).

If the pull came from the distribution of existing governments in Somalia’s part of the world, which may be more sensible given Somalia’s similar “historical constraints,” I think that argument would get even stronger.

If the pull instead came from the western world, I think that argument would fall apart.

Advocates of Somali government seem to have the latter pull in mind. But I can’t figure out why: as I suggest above, these are the exceptions among governments in the world, not the rule.

Of course, a reasonable disagreement can exist about what the relevant institutional alternative to Somali anarchy is. I take this to be what Chris is offering by raising the question of trajectory and long-run, "good" (or at least better) government possibilities. And I have no objection to it.

What I don’t think is reasonable is simply assuming--for the short run or the long run--that the institutional alternative to Somali anarchy is something like government of Switzerland, which is what lots of people I talk to about Somalia seem to have in mind when they argue that government would obviously be better.

3. Chris suspects the improvement in Somali development under anarchy has been in the microstates of Somaliland and Puntland.

In my paper I address this issue and show that, according to the data at least, “microstate Somalia” hasn’t been the exclusive locus of development improvement in Somali post-1991 (Somaliland does do better than stateless, southern Somalia; but Puntland does worse). My friend, Ben Powell, who has also published research on statelessness in Somalia addresses this issue in greater depth (if I recall correctly). I believe he finds the same.

Is the “average” situation in Somalia anarchic or formally governed? I don’t know . . . In part this is because I don't how reasonable it is to think about Somaliland or Puntland as “governments.” If a “government” lacks the power to raise taxes, it doesn’t strike me as much of a government. But a reasonable person could disagree.

4. Someone in the comments on Chris’ blog suggests that my paper uses the wrong counterfactual. I should compare Somalia without government to Somalia’s neighbors, which have governments, not to Somalia under its own government before it collapsed.

I agree that this comparison is (also) important. That’s why in my paper I consider it. (You need to read the published version of the paper, which contains this comparison, not the working-paper version on my website, which doesn’t. I would prefer to have the published version on my website. But copyright law prevents me).

Here’s the result: stateless Somalia continues to look pretty good. My colleague, Claudia Williamson, and I undertake a different look along these lines in our paper published in the Law and Development Review: “Anarchy and Development: An Application of the Theory of Second Best.” Ben Powell, whose paper I mention above, does so too. The results in these papers are similar.

5. Chris wonders whether international attempts to reestablish a central government in Somalia are more likely to lead to stability or violence.

I haven’t studied Somalia closely in years. But my recollection from when I was studying it closely was that spikes in turmoil and violence under statelessness were positively correlated with attempts to reestablish a central government. Such attempts disturbed the equilibrium of “power sharing” between “warlords” that prevailed up to those interventions, putting the “big stick” up for grabs. So people fought for access to the “big stick.”

If this is right, does that mean that attempts to reestablish central government couldn’t, in some much longer-term way that we can forsee, help produce stability? No. But that doesn’t strike me as a very strong reason to support the attempted reestablishment of central government in Somalia.

Greg Ip showed a lack of understanding of the Austrian school of economics that he purports to criticize. Mr. Ip claimed that Austrians believe recessions are “natural features of capitalism” and that monetary policy cannot fix them.

The second claim is true, but the first claim is not. The Austrian view is that recessions are the consequence of preceding inflationary booms that are themselves caused by expansionary monetary policy. Government central banks are responsible for the monetary excesses that eventually lead to recession.

Expansionary monetary policy not only cannot cure recessions; it is their very cause. Those central banks are not a “natural feature” of capitalism but, rather, were established by governments as a device to raise revenue, often for war, and distort economies for political gain.

Steven Horwitz, Canton N.Y.

So that's a win. The loss? Here's the headline on the letters section:

How Austria’s economic model really works

<facepalm> Is it okay to write a letter to the editor complaining about the editing work of the editor of the letters to the editor page?